The Global Economy in Turbulent Times

CHAPTER 69 Burgernomics and the Ringgit¹

I am often asked: What is per-capita PPP income? What does US$5,000 income at PPP prices mean? Off-and-on, the term PPP intrudes into our lives via TV news, newspapers, and economic reports. PPP stands for purchasing power parity—a theory in economics first developed by Swedish economist Gustav Cassel after World War I (WWI). Simply put, this doctrine states that the exchange rate is determined by the relative purchasing power of any two currencies. The common sense of this is that the same amount of money should purchase the same product in any two countries (whence the term purchasing power parity). That is, the purchasing power of money, expressed in one currency, should change pari-passu in different countries. If US$5 buys a cup of Starbucks coffee in New York and the actual cost of the same Starbucks coffee in Kuala Lumpur is RM12, then the exchange rate should be US$1 = RM2.40 according to PPP. But the actual real-life exchange rate is close to RM3.60, or 33 percent cheaper.

PPP in Today’s World

Is PPP relevant? To answer, we need to backtrack. During WWI, trade had been disrupted between allies and halted with enemies. When trade resumed after the war, a choice of new exchange rates was required. Any return to prewar rates would not make practical sense since countries had experienced significant differing rates of inflation because of the disruption of war. Let’s say before the war, US$1 = 30FF (French franc). Since then, ...